Break-Even Analysis

A break-even analysis is an economic tool which is used to determine the cost structure of a company or the number of units needs to be sold to cover the cost. Break-even is a circumstance where a company neither makes a profit nor loss, but recovers all the money spent.

Break-even analysis is used to examine the relation between the fixed cost, variable cost, and revenue. Usually, an organization with low fixed cost will have a low break-even point of sale.

Importance of Break-Even Analysis:

  • Manages the Size of Units to be Sold- With the help of break-even analysis, the company or the owner comes to know how much units need to be sold to cover the cost. The variable cost and the selling price of an individual product and the total cost are required to evaluate the break-even analysis.
  • Budgeting and Setting Targets- Since a company or the owner know at which point a company can break-even, it makes it easy for them to fix a goal and set a budget for the firm accordingly. This analysis can also be practised in establishing a realistic target for a company.
  • Manage the Margin of Safety- In financial breakdown, the sales of a company tends to decrease. The break-even analysis helps the company to decide the least number of sales required to make profits. With the margin of safety report, the management can execute a high business decision.
  • Monitors and Controls Cost- Companies profit margin can be affected by the fixed and variable cost; therefore, with break-even analysis, the management can detect if any effects are changing the cost.
  • Helps Design Pricing Strategy- Break-even point can be affected if there is any change in the pricing of a product. For example, if the selling price is raised, the quantity of the product to be sold to break -even will be reduced. Similarly, if the selling price is reduced, a company needs to sell extra to break-even.

Components of Break-Even Analysis:

  • Fixed Cost- These costs are also known as an overhead cost. These costs materialize once the financial activity of a business starts. The fixed price includes taxes, salaries, rent, depreciation cost, labour cost, interest, energy cost etc.
  • Variable Cost- This cost fluctuates, and will decrease or increase according to the volume of the production. This cost includes packaging cost, cost of raw material, fuel, and other material related to production.

Uses of Break-Even Analysis:

  • New Business- For a new venture, break-even analysis is essential. It guides the management with pricing strategy and be practical about the cost. This analysis also gives an idea if the new business is productive.
  • Manufacture New Product- If an existing company is going to launch a new product, they still have to focus on break-even analysis before starting, and see if the product adds necessary expenditure to the company.
  • Change in Business Model- Break-even analysis works even if there is a change in any business model, like shifting from retail business to wholesale business. This analysis will help the company to determine if the selling price of a product needs change.

Break-Even Analysis Formula

Break-Even Point = Fixed Cost / Price Per Cost – Variable Cost

Example of Break-Even Analysis

Company X sells a pen. The company first determined that the fixed costs of Company X are a lease, property tax, salaries, which make a sum of ₹1,00,000. The variable cost linked with manufacturing one pen is ₹2 per unit. So, the pen is sold at a premium price of ₹10.

Therefore, to determine the break-even point of Company X premium pen will be:

Break-Even Point = Fixed Cost / Price Per Cost – Variable Cost

= ₹1,00,000 / (₹12 – ₹2) = 10,000

Therefore, given the variable costs, fixed costs, and the selling price of the pen, Company X would need to sell 10,000 units of pens to break even.

The above mentioned is the concept, that is elucidated in detail about ‘Break-Even Analysis’ for the Commerce students. To know more, stay tuned to BYJU’S.

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